International Debt Deleveraging

52 Pages Posted: 9 Mar 2015

See all articles by Luca Fornaro

Luca Fornaro

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Barcelona Graduate School of Economics (Barcelona GSE)

Date Written: March 2015

Abstract

This paper provides a framework to understand debt deleveraging in a group of financially integrated countries. During an episode of international deleveraging, world consumption demand is depressed and the world interest rate is low, reflecting a high propensity to save. If exchange rates are allowed to float, deleveraging countries can rely on depreciations to increase production and mitigate the fall in consumption associated with debt reduction. The key insight of the paper is that in a monetary union this channel of adjustment is shut off, because deleveraging countries cannot depreciate against the other countries in the monetary union, and therefore the fall in the demand for consumption and the downward pressure on the interest rate are amplified. Hence, deleveraging can easily push a monetary union against the zero lower bound and into a recession.

Keywords: Debt Deflation, Global Debt Deleveraging, Liquidity Trap, Monetary Union, Precautionary Savings, Sudden Stops

JEL Classification: E31, E44, E52, F32, F34, F41, G01, G15

Suggested Citation

Fornaro, Luca, International Debt Deleveraging (March 2015). CEPR Discussion Paper No. DP10469, Available at SSRN: https://ssrn.com/abstract=2575773

Luca Fornaro (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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